Qualifying Income Tax In The UAE Free Zone: Pay Attention, Or Pay Tax

Be aware of the ‘De-Minimis’ Threshold and hire an accountant or face serious financial risks and penalties

The UAE’s new Corporate Income Tax code has kicked in from June 1^st and requires specific attention from foreign investors based in the UAE Free Zone (FZ). It should be noted by all companies in the FZ that if at any time during a year, a FZ entity fails to meet any of the prescribed conditions for the zero per cent tax rate, it will remain ineligible for the zero rate for a further four years.

This means that during an FTA audit (typically after 5-6 years) you are found to be ineligible as a qualifying free zone (QFZP) company, the tax incentives claimed during the previous four years will be automatically denied, and result in tax arrears payments and late tax payment penalties. The situation therefore is serious and should be considered as a key part of understanding your new tax liabilities in the UAE.

What is “Disqualifying Income”?

There have been considerable misinformation concerning the concept of ‘disqualifying income’ and it is important to take professional advice on the matter. There are a number of scenarios that can trigger a FZ business as being disqualified, a subject we discussed in this article here. It is vitally important these distinctions are fully understood to prevent serious liability and financial problems later on.

Qualifying Income

‘Qualifying income’ is taxable at 0 per cent. The term applies to two features: Scope and Prescribed Conditions.

Qualifying Income Scope means:

Income from any transactions with other free zone person (same or different free zone); and

Income from ‘qualifying activities’ with a non-free zone person (be it domestic or foreign).

Qualifying income should not be attributable to a domestic or foreign permanent establishment, if the place of management of the business is in the UAE mainland and/or overseas. But if the resultant transactions are shown under a free zone person, the 0 per cent rate could be denied.

Qualifying Income does not include:

Income from ‘excluded activities’;

Income attributable to immovable property (located in a free zone) which is either not used exclusively for business or business activities or the transaction is with a non-free zone person. The expression ‘attributable to’ for tax purposes has been subjected to varied interpretations in judicial decisions across the world.

It is very important these differences are fully understood.

These conditions are critical – yet could be difficult to demonstrate during the statutory audit. Similarly, income attributable to a UAE mainland branch of the business would also not be eligible for 0 per cent.

While qualifying income includes income from any transactions with other free zone persons, the recipient should be the ‘beneficial recipient’. The right to use and enjoy the goods/services should be with the recipient free zone persons without any contractual or legal obligation to pass it on to another person.

How a free zone person-supplier could ensure the recipient’s status and handle scenarios like back-to-back contracts or undisclosed agents requires pertinent and persistent evaluation. Ideally, all such transactions should be verified by your internal accounting staff prior to being booked. If you do not have such personnel, now is a good time to recruit.

Qualifying Activities

A UAE Ministerial decision has listed down the ‘qualifying activities’ eligible for the 0 per cent tax rate. Notable activities include manufacturing or processing of goods, HQ services to related parties, treasury and financing to related parties, and holding of shares and other securities.

The 0 per cent rate also applies on income from the distribution of goods in or from a VAT designated zone (DZ) to a customer that either resells such items or processes/alters such items for sale. Given the strict conditions on the intended use of the goods, sale of plant and machinery, consumables, office furniture, office equipment etc. from DZ for end-use needs to be examined as they are not further processed or altered.

Excluded Activities

A list of activities have also been prescribed which are excluded from 0 per cent tax rate. Barring a few specialised transactions, any transactions with natural persons is an ‘excluded activity’. In other words, transactions for example the sale of goods to individuals in or from free zone/designated zone will require monitoring. The ownership or exploitation of IP assets is also an ‘excluded activity’, potentially creating a significant tax impact.

The De-Minimis Rule

The De-Minimis threshold allows the ‘non-qualifying’ revenue of a free zone person to be taxed at 0 per cent. The ‘non-qualifying’ revenue includes income from ‘excluded activities’ and from activities (other than ‘qualified activities’) with a non-free zone person.

The threshold is the lower of 5 per cent of its total revenue or Dh5 million (US$1.36 million). Exceeding either of these triggers corporate income tax at 9%.

Income attributable to domestic/foreign permanent establishment is not included in the ‘non-qualifying’ revenue. Accordingly, the income attributable to say, a mainland branch will remain taxable at 9 per cent irrespective of the quantum and threshold. Something that we discussed in this column in April.

Disqualifying Income

Accountants need to be careful here in booking disqualifying income yet it being assessed as an eligibility condition. One of the conditions in the ministerial decision for 0 per cent eligibility is that the free zone person must ensure that the ‘non-qualifying’ revenue does not exceed the de-minimis threshold.

This means that income above the de-minimis threshold will be taxable at 9 per cent irrespective of the total revenue. The total would become ineligible for 0 per cent rate and then subject to the 9 per cent rate. Do not exceed the De-Minimis threshold!

For professional assistance and opinions please contact Dezan Shira & Associates Dubai at dubai@dezshira.com

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